Free Headquarters' Overhead Cost Allocation at Korea Auto Insurance Co. Inc. Case Study Solution | Assignment Help

Gary F. Smith
Written by Gary F. Smith
Publish Date: 2024-12-03

Harvard Case - Headquarters' Overhead Cost Allocation at Korea Auto Insurance Co. Inc.

"Headquarters' Overhead Cost Allocation at Korea Auto Insurance Co. Inc." Harvard business case study is written by Sangil Kim, Ho-Young Lee, Won-Wook Choi. It deals with the challenges in the field of Accounting. The case study is 8 page(s) long and it was first published on : Oct 22, 2009

At Fern Fort University, we recommend Korea Auto Insurance Co. Inc. (KAIC) implement an activity-based costing (ABC) system to allocate overhead costs more accurately. This will provide a more realistic view of the cost of each department, leading to better decision-making and improved profitability.

2. Background

Korea Auto Insurance Co. Inc. (KAIC) is a leading insurance company in South Korea, facing challenges in allocating overhead costs from its headquarters to its regional branches. The current system, based on the number of employees, is deemed inaccurate and fails to reflect the actual resource consumption by each branch. This leads to distorted performance evaluations and hinders effective resource allocation. The case study highlights the need for a more accurate and transparent cost allocation method to address these issues.

The main protagonists in the case study are:

  • Mr. Kim, the CEO of KAIC: Concerned about the accuracy of the current overhead allocation system and its impact on the company's overall profitability.
  • Mr. Lee, the CFO of KAIC: Tasked with finding a more accurate and efficient way to allocate overhead costs.
  • The regional branch managers: Concerned about the fairness and accuracy of the current cost allocation system, which affects their performance evaluations and resource allocation.

3. Analysis of the Case Study

The case study highlights several key issues with KAIC's current overhead cost allocation system:

  • Inaccurate Cost Allocation: The current system, based on the number of employees, fails to reflect the actual resource consumption by each branch. This leads to distortions in cost allocation, making it difficult to assess the true profitability of each branch.
  • Lack of Transparency: The current system lacks transparency, making it difficult for branch managers to understand how overhead costs are allocated and how they can influence these costs. This can lead to frustration and a lack of accountability.
  • Limited Decision-Making: The inaccurate cost allocation system hinders effective decision-making. It makes it difficult to determine the true cost of providing services to customers, leading to suboptimal pricing strategies and resource allocation.
  • Distorted Performance Evaluation: The inaccurate cost allocation system distorts performance evaluations of branch managers. This can lead to unfair comparisons and demotivate employees.

To address these issues, KAIC needs to implement a more accurate and transparent cost allocation system. Activity-based costing (ABC) is a suitable solution, as it allocates costs based on the actual activities performed by each branch.

4. Recommendations

KAIC should implement an activity-based costing (ABC) system to allocate overhead costs more accurately. This involves the following steps:

  1. Identify Cost Drivers: Identify the activities that drive overhead costs, such as claims processing, customer service, marketing, and IT support.
  2. Assign Costs to Activities: Allocate overhead costs to each activity based on the resources consumed, such as labor, materials, and overhead.
  3. Allocate Costs to Branches: Allocate costs to each branch based on their usage of each activity. This can be done by tracking the number of claims processed, customer service calls, marketing campaigns, and IT support requests.
  4. Implement a Tracking System: Develop a system for tracking and monitoring the usage of each activity by each branch. This will provide accurate data for cost allocation.
  5. Communicate and Train: Communicate the new cost allocation system to all stakeholders, including branch managers, employees, and executives. Provide training on how to use the new system.

5. Basis of Recommendations

The recommendation to implement an activity-based costing (ABC) system is based on the following considerations:

  1. Core Competencies and Consistency with Mission: ABC aligns with KAIC's mission to provide high-quality insurance services by ensuring that costs are allocated accurately and fairly.
  2. External Customers and Internal Clients: ABC improves customer satisfaction by ensuring that costs are allocated to the services they receive. It also improves internal client satisfaction by providing a more transparent and accurate cost allocation system.
  3. Competitors: Implementing ABC can help KAIC stay competitive by providing a more accurate understanding of its costs and allowing for better pricing strategies.
  4. Attractiveness ' Quantitative Measures: ABC can improve profitability by providing a more accurate view of the cost of each branch, leading to better decision-making and resource allocation.

6. Conclusion

Implementing an activity-based costing (ABC) system will provide KAIC with a more accurate and transparent method for allocating overhead costs. This will lead to improved decision-making, enhanced profitability, and a more accurate assessment of branch performance.

7. Discussion

Other alternatives to ABC include:

  • Traditional Cost Allocation Methods: These methods, such as allocating costs based on the number of employees or sales revenue, are less accurate and transparent than ABC.
  • Hybrid Cost Allocation Systems: These systems combine elements of traditional and ABC methods, but they can be complex and difficult to implement.

The risks associated with implementing ABC include:

  • Implementation Costs: Implementing ABC can be costly, requiring significant investment in data collection and analysis.
  • Resistance to Change: Some employees may resist the change to a new cost allocation system.
  • Complexity: ABC can be complex to implement and maintain.

8. Next Steps

KAIC should take the following steps to implement ABC:

  1. Form a Task Force: Form a task force to develop and implement the ABC system.
  2. Identify Cost Drivers: Identify the activities that drive overhead costs.
  3. Develop a Tracking System: Develop a system for tracking and monitoring the usage of each activity.
  4. Pilot Test the System: Pilot test the ABC system in a few branches before rolling it out company-wide.
  5. Communicate and Train: Communicate the new cost allocation system to all stakeholders and provide training on how to use the system.

By taking these steps, KAIC can successfully implement an ABC system that will improve its cost allocation accuracy, enhance decision-making, and improve overall profitability.

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Case Description

Korea Auto Insurance Co. Inc. (Korea Auto Insurance) incurred both direct and indirect costs. Direct costs were incurred at branches as they performed sales and operating activities, while indirect costs were incurred at headquarters as it supported branches through the activities of the information technology, operating support, investment, marketing and general administrative teams. Indirect costs accounted for a significant part (41 per cent) of the total costs incurred. However, they could be neither directly traceable nor logically related to specific sales activities. Korea Auto Insurance currently allocated indirect costs incurred by headquarters to branches based on sales revenue. Using the amount of sales revenue as an allocation base for overhead was not regarded as a reasonable method by the Taejon City branch manager. Branch managers had complained that the current allocation base was not related to the level of actual benefits they received from the headquarters. They argued that the allocation process distorted the operating performances of branches as reflected in the books. The manager of the Taejon branch suggested that the ABC (activity-based cost) method be applied to solve the problems related to the current overhead allocation process.

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